Is Misrepresenting Inventory?

Patrick Byrne of O.coI’ve been taking a look at some of the inventory numbers in Overstock’s most recent 10-K. I have plenty to say about the issue, but thought it would be fun to raise just one question for now…

The 2006 Overstock 10-K represents the following:

We ended 2006 with $20 million of inventory, significantly lower than the $93 million we had at the end of 2005. From this lower inventory level, we expect to turn our inventory much more efficiently. We have entered 2007 with more attractive, higher margin inventory, and as a result, we expect our gross margins in 2007 to increase significantly over 2006 levels.

Let me emphasize the assertion of more attractive, higher margin inventory.

Really? That doesn’t compute when you look at the inventory numbers on the balance sheet. There’s a little accounting concept called “reserve for obsolete inventory.” In non-accounting terms, it’s the stuff that the company is willing to admit is junk.

Check out these numbers:

At 12/31/05, Overstock reported $98.5 million of inventory, with a reserve of $5.2 million. The reserve was 5.3% of the total inventory.

At 12/31/06, Overstock reported $26.9 million of inventory, with a reserve of $6.6 million. The reserve was 24.5% of the total inventory.

So let’s get this straight… in terms of raw dollars, the obsolete (junk) inventory was greater at the end of 2006 than it was at the end of 2005. And as a percentage of total inventory, the obsolete (junk) inventory was over 4 times higher than 2005.

How is this inventory more attractive when you’re admitting that 1/4 of it is junk??? Or, was way more junk sitting around in 2005, but the company purposely did not reserve for it? (Which would, oddly enough, probably be a material misstatement in the financial statements.)

Other interesting reading about Overstock and CEO Patrick Byrne:
Sam Antar suggests some questions for the SEC to ask of Byrne and company
Gary Weiss on what might be considered materially misleading

9 thoughts on “Is Misrepresenting Inventory?”

  1. Tracy,

    Is it possible that the inventory reserve # includes reserves for returned mechandise?


  2. The reserve for returns is a separate item. Per the 10-K:

    “The reserve for returns was $5.6 million and $3.6 million as of December 31, 2005 and 2006, respectively.”

    You may also notice that the decreased reserve gave the company $2 million in additional income for 2006…

  3. Much as I’d like to agree with you about this, it seems to me that the more likely explanation is that it’s not so easy to get rid of the crap inventory, so that as they reduced the large pile they had, the crap amount remained relatively stable, because they still had it. Thus it became a larger percentage of what they had left. Given the way businesses tend to operate, I don’t find that particularly unlikely. Are you going to devote your time to moving out the inventory that nobody wants? Or are you more likely to spend time trying to do things that will increase revenue?

    To me, the important question is this one: how can the same business go from $90ish million in inventory to $20ish million? Were they idiots then, or are they idiots now?

  4. Yet the’ve said the inventory is MORE ATTRACTIVE. That’s the whole point here… I understand they’ve got crap. Why, then would they call it “more attractive”?

  5. Maybe $15 million of nice stuff and $5 million of crap is, on balance, more attractive than $20 million of nice stuff, $65 million of “eh” stuff, and $5 million of crap. The crap is as unattractive as it was before, so there’s no real difference there, and the remainder is significantly more attractive.

    Of course I can’t pretend to know that that’s what they mean. I’m just not sure there’s a big point here, as there seem to me to be perfectly plausible alternative explanations (and much bigger things to aim at when trying to pick nits about this company).

  6. Would you consider it material if was consistently managing earnings, in part by manipulating inventory numbers?

  7. Sure, why not? But these are subtleties compared to the CEO’s maniacal treatment of the press, time-wasting anti-naked short selling jihad, inability to decide what business the company is actually in, approval of a lunatic fringe website ( and waving a sign around on television with its URL, approval of an enemy-bashing and message-board-poster-outing website ( run by an employee and exposing the company to god knows what potential liabilities, claims of technology brilliance followed by a technology diaster, “miscreant’s ball” conference call, lawsuit against prime brokers, lawsuit against an independent research outfit, and as I mentioned earlier, the giant drop in inventory levels indicating who-knows-what level of incompetence in managing the business — against that background, mere inventory manipulation fades into insignficance, even if present.

  8. Well I just talk about what I know, and I know financial statements and notes. Your point is well taken. 🙂

  9. Lost in this discussion is the fact that most of their volume is generated by products that never enter their inventory…they’ve lost many of their “better” brands in some product categories, and have alienated suppliers with questionable proceedures and charges in others. Added to that is the clownish nature of their management team…is there a better candidate for takeover by a private equity firm?

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